How to navigate through Trump’s brave new world

The US president is ripping up the rule book and charting a fresh course. We need to wake up and adapt to the new agenda.

US President Donald Trump speaks during a press conference. The sooner Canberra understands that the game has changed the better. (AFP/Nicholas Kamm)

Warren Buffett’s decision to sell out of Walmart was not just because of a fear of the impact of Amazon and other online retailers on bricks and mortar retailing.

The great man has looked hard at the road map guiding us towards what President Trump is planning for the US. Once Buffett did that, he realised that the challenges facing US retailers go way beyond Amazon.

And so today I want to share with you a Trump US road map that I have prepared after yarning with Ron Temple, Lazard’s managing director, head of US equities and co-head of multi-asset investing.

The fascinating facts and figures in the Trump road map come from Lazard but the conclusions are mine.

So far, unlike most politicians, Donald Trump actually does what he promised, so the road map has extra validity. And once you understand the road map you will realise that the globalised world we have known for the last three decades has ended. The sooner we wake up and adapt the better.

The media elites have concentrated on the social/community measures of Trump. Our road map concentrates on business, where tax cuts are top of the agenda (tax cuts are actually second on the House Republican’s agenda; abolishing Obama care is first).

The Republicans in the House want to cut the US company tax rate from 35 to 20 per cent, which will cost a massive $US1.85 trillion (all dollar figures in this commentary are US) or 0.74 per cent of GDP over ten years.

President Trump wants to go further and cut the corporate tax rate from 35 to 15 per cent, which represents a cost of $2.35 trillion over 10 years or $500 billion more than the House Republican figure. The final tax cut may be somewhere in between.

That’s tax step number one.

Step two in the tax cut is to make all capital investment tax deductible. That ends depreciation as a cost. Under the House Republican plan there will be no choices. Part of the cost will be recouped by not allowing interest as a tax deduction.

The Lazard estimated net cost of the two measures (capital write-offs and non-deductibility of interest) is $US450bn over 10 years.

Trump has a slightly different plan. He wants to give US companies a choice. If you decide to depreciate you can also deduct interest for tax.

The Trump scheme actually lifts the net extra cost from $US450bn to $US600bn.

In total, we are looking at the House Republican cost of $US2.3 trillion against Trump’s $US2.9 trillion over 10 years.

This system of tax is very simple but it means that if you can’t deduct interest, then high leverage no longer makes much sense (banks will surely get some relief).

Private equity people are not at all happy because their model relies on high leverage.

A whole new game will take place in the capital structure of US companies.

There are also foreign tax credit measures that add small amounts to the cost.

Step three is to suck the vast sums sitting in corporate accounts overseas, which American companies are not bringing to home because of the high US tax rates. Trump wants a 10 per cent tax on money coming home which Lazard estimate will raise $US150bn over 10 years.

The House Republicans have a more complex scheme which raises slightly less. Both measures are expected to bring vast sums back home to the US where they may find a much higher interest rate environment than is currently the case.

As a result, step four, which is how Donald Trump plans to raise the largest sums. In many ways step four is the most revolutionary: All import costs will be denied a tax deduction, which will raise a massive $US1.2 trillion over 10 years.

This is actually a House Republican measure which has not been fully endorsed by Trump who is also looking at tariffs because he can use them with devastating effect to force investment in the US.

The House Republican plan seems to be interchangeable with higher tariffs but is much more elegant and easier to introduce.

Either denying tax deduction for imports or imposing tariffs is an essential part the Trump plan, although many believe it will never happen. They may be right but Buffett is playing it safe.

It is possible there will be some trading deal with Mexico and China to reduce or delay the impact but the non-deductibility of imports will raise $US1.2 trillion over 10 years or about half the cost of introducing Trump’s 15 per cent corporate tax rate. It is essential to the road map.

In all, Lazard estimate that the net cost of the House Republican Measures is $US890bn over 10 years, which is only 0.35 per cent of US GDP over the period and that GDP may grow at a faster rate.

Trump’s measures cost more but not that much depending on what happens with tariffs and non-deductibility of imports.

As Australia looks to cut company tax rates it is not planning to introduce tariffs or impose non-deductibility of import expenditure as an offset.

So, let’s look at how non-deductibility of import expenditure might affect a group like Apple. Hypothetically, Apple may import from China a mobile phone for, say, $800, and sell it in the US for $1,600. It will get no tax deduction for the $800 so the entire $1,600 is profit less whatever American labour and other costs are involved in distribution.

If the Trump plan is introduced, then the effect on retailers like Walmart will be much more severe than groups like Apple.

To the extent that US retailers are selling imported goods they will not be able to claim a tax deduction on their imports or will face big tariffs. The Walmart sales proceeds on imported goods will become the profit less the US labour and other costs in retailing.

Remember Walmart margins are much lower than Apple and, like other retailers, most of their goods are imported.

If nothing else happened, the Walmart profit would be hit very hard but in practice they will raise their prices.

But online retailers like Amazon will curb their ability to lift prices. Nevertheless welcome to inflation in the US.

Already American inflation is stirring but the Trump road map sends it much higher. Along with higher inflation goes much higher US interest rates.

Of course, there will also be less demand for corporate bonds because as interest rates rise there will be no tax deductibility. US banks will benefit from the higher interest rates and the deregulation that also comes as part of the Trump plan. All American industry is thirsting for less regulation.

Historically governments have repaid debt via inflation. That’s what Trump is doing.

Whether it is via tariffs or via the simpler non-deductibility of import expenditure, the US would be breaking WTO rules.

The Trump people say it will take five years to argue the point in the courts by which time Trump may be in a second term. The US may make it easy and leave the WTO.

So that’s the basic road map.

It will not suddenly cause all production to leave Mexico and China for the US because the labour costs are so much lower. And in the case of Mexico the decline in the currency has further reduced labour costs.

But I have no doubt that all major manufacturers in China and Mexico exporting to the US will be required to increase their investment in US plants to honour the Trump jobs pledge.

If they don’t, they will soon find themselves excluded from government contracts or some other ‘nasty’.

It’s hard to know how long the process will take but Trump wants to move fast.

Once Europe understands the US game there will be incredible pressure to follow. Ansell in Australia is looking to put a plant in the US and will almost certainly do so if Trump implements his road map.

There will be pressure in Australia to change our US trade deal.

The sooner Canberra understands that the game has changed the better.

We don’t win from this. As US interest rates go up so will the cost of those borrowing overseas — led by Australian banks — so there will be upward pressure on our rates … and so on.